Mortgage closing disclosures can be confusing.
A borrower may be told that a loan has only a few thousand dollars in actual closing costs, yet the Closing Disclosure shows $10,000, $15,000 or substantially more due at closing.
That does not necessarily mean the mortgage suddenly became much more expensive.
The reason is that the amount shown as cash to close can include several very different categories of money.
Some amounts are true costs of obtaining the mortgage.
Others are taxes, homeowners insurance, prepaid interest or money being placed into an escrow account to pay future expenses.
Understanding the difference is extremely important when comparing mortgage offers.
I’m John Madden, owner of Capital Funding Mortgage, and I have been originating mortgages since 1999.
One of the things I believe borrowers should clearly understand before closing is:
What am I actually paying to obtain this mortgage, and what money am I simply paying now because of the timing of the transaction?
This guide explains the difference.
This is the most important concept on the entire page.
Your closing costs are not necessarily the same as the total amount of money you need at closing.
Your cash to close may include:
Some of these are true transaction costs.
Some are not.
For example, putting $4,000 into an escrow account does not mean the lender charged you a $4,000 fee.
It means money is being collected to help pay future property taxes or insurance bills.
I generally encourage borrowers to think about closing funds in four broad categories.
On a purchase, this is the portion of the purchase price that you are not financing.
For example:
Purchase price: $500,000
Loan amount: $450,000
Down payment: $50,000
The $50,000 is not a closing cost.
It is equity you are putting into the property.
Likewise, on a refinance, you may sometimes bring money to closing to reduce the loan balance.
That money is not necessarily a cost of the refinance.
These are the expenses most borrowers are really referring to when they ask:
“How much does this mortgage cost?”
They may include:
These are the costs you should pay particularly close attention to when comparing lenders.
Certain expenses may need to be paid in advance at closing.
These can include:
These payments may be required because of when the closing occurs, not because one lender is necessarily more expensive than another.
If your mortgage includes an escrow account, the lender may collect money at closing to establish that account.
The escrow account can later be used to pay:
Again, these funds should not automatically be treated as lender fees.
They are your funds being held for future expenses.
Lender-related fees can appear in several forms depending upon the loan.
They may include:
Different lenders structure these charges differently.
One lender may quote a slightly better interest rate but charge substantially more in fees.
Another may offer a slightly higher rate with little or no lender fee.
That is why comparing only the interest rate can be misleading.
Discount points are an upfront cost paid in exchange for a lower interest rate.
Generally:
1 point = 1% of the loan amount.
For example, on a $500,000 mortgage:
1 point = $5,000.
That does not mean paying points is automatically good or bad.
The important question is:
Suppose you have two choices:
Option A
6.00% interest rate
$5,000 in points
Option B
6.375% interest rate
No points
If the lower rate saves $125 per month:
$5,000 ÷ $125 = approximately 40 months
Your approximate break-even period would be 40 months.
If you expect to keep that mortgage substantially longer than 40 months, paying the points may deserve consideration.
If you expect to sell or refinance sooner, the no-point option may be more attractive.
This is why I prefer to show borrowers the mathematics rather than simply telling them which rate is “better.”
Lender credits work in the opposite direction.
A borrower may choose a somewhat higher interest rate and receive a lender credit that helps pay closing costs.
For example:
Option A: Lower rate + $4,000 in costs
versus
Option B: Slightly higher rate + $4,000 lender credit
Neither option is automatically better.
The correct choice depends upon:
You may see advertisements for:
No-closing-cost mortgages
or
Zero-cost refinances.
That does not necessarily mean nobody is being paid.
Often, the lender provides a credit that offsets some or all of the closing costs in exchange for a higher interest rate.
That can be an excellent strategy in the right circumstances.
For example, if you refinance with little or no cost and significantly reduce your monthly payment, you may not have a long break-even period.
But you should understand exactly how the transaction is structured.
Ask:
Mortgage interest is generally paid differently from rent.
When you make a mortgage payment, you are generally paying interest for the previous month.
At closing, the lender may therefore collect interest from the closing date through the end of that month.
For example, if you close near the beginning of a month, you may have more prepaid interest than if you close near the end.
That does not mean the lender with the earlier closing date is charging a higher mortgage fee.
It is primarily a timing issue.
Property taxes can create significant confusion on both purchases and refinances.
Depending on:
there may be tax payments, prorations or escrow collections at closing.
This is particularly important in Pennsylvania and New Jersey, where property taxes can vary considerably between municipalities and properties.
When comparing Loan Estimates, do not assume a lender is cheaper simply because its initial tax estimate is lower.
The property tax obligation ultimately comes from the property and taxing authority—not from the mortgage company.
Most lenders require acceptable homeowners insurance before closing.
On a purchase, the borrower may be required to pay an insurance premium in advance.
The lender may also collect additional insurance funds for the escrow account.
These amounts can increase cash to close but are not necessarily lender charges.
An escrow account is used by the mortgage servicer to collect money with your monthly payment for future expenses such as:
When the applicable bill becomes due, the servicer pays it from the escrow account.
When a new escrow account is established, enough money may need to be collected at closing to properly fund the account.
This can sometimes be several thousand dollars.
Again:
Escrow deposits are not the same thing as closing costs.
That distinction is extremely important.
This is another source of confusion.
If you refinance an existing mortgage that has an escrow account, your old lender or servicer may still be holding money in that account.
Your new lender may need to establish a new escrow account at closing.
This can temporarily make it appear that you are paying the escrows twice.
However, after the old mortgage is paid off, the remaining eligible escrow balance is generally returned to you by the old servicer under applicable servicing procedures.
That refund is separate from your new closing.
This is why a refinance Closing Disclosure can sometimes show a surprisingly large amount of money associated with escrows even though the actual refinance costs are much smaller.
Title-related charges may include services associated with:
These costs vary based on the transaction and location.
Do not assume every title-related charge is a lender fee.
Some of these services are provided by third parties.
These are different forms of protection.
A lender's title insurance policy generally protects the mortgage lender's interest in the property.
An owner's title insurance policy generally protects the property owner's interest, subject to the terms and exclusions of the policy.
On purchases, borrowers should understand which policies are being purchased and what each one protects.
Questions about legal title protection should also be discussed with the title professional or attorney handling the transaction.
Mortgages and deeds generally need to be recorded with the appropriate governmental authority.
The transaction may therefore include:
These charges can vary by jurisdiction and transaction type.
They are not usually controlled by the mortgage broker.
Depending upon the loan program and down payment, mortgage insurance may apply.
Examples can include:
Mortgage insurance should be considered when comparing the true monthly cost of loan alternatives.
For example, a conventional loan and FHA loan may have different:
Looking only at the interest rate can therefore produce the wrong conclusion.
A purchase transaction may include:
But remember:
Your down payment is not a closing cost.
And much of the money associated with taxes, insurance and escrows may represent obligations you would have as a homeowner regardless of which lender you choose.
A refinance may include:
One of the most important calculations is the break-even period.
Suppose a refinance costs $4,500 and saves you $225 per month.
$4,500 ÷ $225 = 20 months
That means it takes approximately 20 months of payment savings to recover $4,500 in costs.
But even that analysis should consider:
A refinance should not be evaluated solely by asking:
“Is the new payment lower?”
On purchase transactions, a seller may sometimes agree to contribute toward certain buyer closing costs, subject to the purchase agreement and applicable loan-program limits.
Seller credits can reduce the buyer's out-of-pocket closing expenses.
However, a seller credit does not necessarily reduce:
The structure should be reviewed before the purchase agreement is finalized.
After a borrower makes a mortgage application and provides the required information, the lender generally provides a Loan Estimate showing important information about the proposed mortgage.
Among other things, it can show:
The Loan Estimate is one of the most useful documents for comparing mortgage offers.
But it needs to be read correctly.
Two lenders may estimate taxes or insurance differently even though the actual property expenses will ultimately be the same.
When comparing lenders, I focus particularly on the items that actually differ because of the financing.
Before closing, the borrower receives a Closing Disclosure showing the final or near-final terms and costs of the transaction.
The Closing Disclosure allows you to review:
One of the things I do for my clients is review the closing figures to make sure the loan costs are consistent with what we expected.
This is a major mistake.
Suppose:
Lender A cash to close: $18,000
Lender B cash to close: $14,000
At first glance, Lender B looks $4,000 cheaper.
But what if Lender A included:
$3,000 more in property taxes and
$1,000 more in escrow funding?
Those items may have nothing to do with which lender is actually cheaper.
To properly compare mortgage offers, separate:
from
from
from
That gives you a much clearer picture.
Suppose your Closing Disclosure shows:
Loan-related and third-party closing costs: $4,000
Prepaid interest: $900
Homeowners insurance: $1,800
Initial escrow deposit: $3,500
Property taxes due: $4,000
The disclosure might show more than $14,000 associated with costs and other charges.
But that does not mean the lender charged you $14,000 to obtain the mortgage.
The actual transaction costs may be closer to $4,000.
The rest represents prepaid expenses, property obligations and funds being set aside for future bills.
That distinction matters.
When comparing lenders, I suggest paying particular attention to:
Then separately review:
A mortgage with the lowest rate is not always the least expensive mortgage.
A mortgage with the lowest cash to close is not necessarily the least expensive mortgage either.
There is usually a tradeoff between:
Interest rate
and
Upfront cost.
A borrower who expects to keep a mortgage for 15 years may make a different choice than someone expecting to refinance or sell in two years.
That is why I prefer to show multiple options when appropriate.
For example:
Lower rate / higher cost
Middle rate / moderate cost
Higher rate / lender credit
Then we can calculate when one option becomes more economical than another.
Before accepting a mortgage proposal, make sure you understand:
You should be able to get understandable answers.
Not in the same sense as a lender or title fee.
Escrow deposits are generally your money being collected to pay future property-tax or insurance obligations.
No.
Your down payment represents equity you are putting into the property.
No.
Property taxes are imposed by the applicable taxing authorities.
No.
The lender may require acceptable insurance, but the insurance premium is paid for coverage on the property.
No.
Points can make sense when the monthly savings justify the upfront cost over the expected life of the mortgage.
Not necessarily.
A lender credit often corresponds with accepting a higher interest rate.
The rate/cost tradeoff should be analyzed.
APR is useful, but it should not be the only factor considered.
The loan structure, expected holding period, cash requirements, rate, costs and amortization all matter.
Some estimates can change based on updated information, third-party charges, transaction changes or other permitted circumstances.
Your final Closing Disclosure should be reviewed carefully before closing.
If you already have a Loan Estimate or mortgage proposal from another lender, you are welcome to have me review it.
I can help separate:
and compare the overall mortgage structure.
The goal is not simply to tell you that one rate is lower.
It is to determine which option appears to make the most financial sense based on the rate, cost, payment, term and expected time you will keep the mortgage.
Mortgage closing documents contain a lot of information, but the underlying concepts do not have to be complicated.
The most important distinction is knowing:
What am I actually paying to obtain this mortgage?
versus
What am I paying now because taxes, insurance, interest or escrow funds are due at closing?
Once you separate those categories, mortgage offers become much easier to understand and compare.
If you are purchasing or refinancing a home in Pennsylvania or New Jersey and would like help understanding your mortgage costs, I would be glad to review the numbers with you.
John Madden Cell 215-601-6724
Owner, Capital Funding Mortgage
Mortgage originator since 1999
Clear numbers. Straightforward explanations. Mortgage decisions based on the complete financial picture.
